A bunch of hedge fund managers got together in a room and talked about how long China has

Guo
Fuxiang (2nd L), a researcher of the Palace Museum, introduces
the damaged Qing-Dynasty clock to journalists during a media
briefing at the Forbidden City in Beijing, May 5,
2013.Reuters

On Wall Street, there are several events during the year when the
Masters of the Universe get together and share ideas. One of the
most important of these is The Grant's Interest Rate Observer
conference, which took place on Wednesday at the Plaza Hotel in
New York City.

There, one investor told the entire room of hedge fund managers
how long China has before it runs out of foreign exchange
reserves.

The country, said Anne Stevenson-Yang co-founder of J
Capital Research, has 9 months before its currency "reserves are
down to a perilous point."

She calculated that reserves, this summer around $3.4
trillion, have dwindled down to $2.9 trillion.

"In 12 months there will be a currency crisis of around
15%," she said. "There will be a banking crisis two years
later."

Go with the flow

China has been experiencing currency outflows of varying
(though generally dramatic) degrees since last August when the
country devalued its currency,
the yuan, by 2%. As its economy slows, more and more
people want to trade in their yuan for some other
currency.

None of this is good for the government, which needs this cash to
pull off the very difficult trick transitioning its economy from
one based on investment, to one based on consumer consumption.
That means restructuring debt-laden corporations and doing things
like supporting millions of people when they're laid off.

Plus, as Stevenson-Yang pointed out in her presentation, the
government needs this cash to keep cash flowing through the
economy.

"Without constant injections of cash, the financial system would
not be able to transact," she said. She thinks the system needs
something around 70 trillion yuan a year to keep going.

Swap you

Because of all of this, the government has put on some pretty
draconian capital controls to stem outflows, and they have eased.
According to government data, only $29 billion left the country
in February as opposed to $99 billion in December. In March,
the government says reserves rose by $10 billion.

Stevenson-Yang isn't totally buying that though.

"The PBOC [People's Bank of China] is using forwards and other
techniques to hide outflows. The volume of swaps, forwards, and
options not totals $4.4 trillion since October. Deposits against
those swaps could be as high as $800 billion. Some of that money
may be obscuring the decline in forex reserves," she wrote in her
presentation.

As those reserves dwindle, the PBOC may be forced to devalue the
currency, according to analysts at CLSA.

As Federal Reserve interest-rate increases buoy the
greenback, defending the yuan will cut China’s currency reserves
to less than $2.75 trillion by the middle of next year, said
Amar Gill, head of Asia research at the brokerage. That will
prompt the nation to move to a free-float regime in the second
half, he said. CLSA forecasts that the Chinese currency will
slump to 8 per dollar by the end of 2017, a weaker level than any
of 44 other analyst projections tracked by Bloomberg. The median
estimate is for a 3.7 percent decline.

If you think this sounds like a vicious cycle, you may be
on to something.